ICYMI: What to expect when demand response goes before the Supreme Court
Legal battles and market uncertainty are the new status quo until SCOTUS rules. And even then, 'certainty' could take many forms.
To those outside the power industry, demand response is energy efficiency’s lesser known sibling.
But DR, as it’s known in industry circles, will soon have its moment in the national spotlight — even if that ‘moment’ is a Supreme Court case that could cut the resource’s value proposition in wholesale energy markets.
The case centers on an order from the Federal Energy Regulatory Commission that essentially put DR on par with traditional generation sources in wholesale energy markets. But while the case may seem obscure and hyper-technical to the general public, it could have wide-ranging implications — not only for DR providers and generators, but for the power sector at large.
Utility Dive spoke with legal experts and market analysts to sort out the possible outcomes, implications, and why the significance of the case may extend far beyond demand response. But before we get into that, let's start with a quick primer on the case. If you already know what's going on and just want the analysis, go ahead and skip past the first section below.
A quick primer: Electric Power Supply Ass’n v. FERC
The case, Electric Power Supply Ass’n v. FERC, stems from a 2011 FERC order setting rules and compensation for demand response resources in wholesale energy markets. The agency effectively ordered energy markets to pay demand response resources the same market price paid for generation if the demand response resource is economical and can help balance supply and demand on the grid in real time.
A coalition of industry trade groups led by the Electric Power Supply Association (EPSA), the industry group for electric generators, have long opposed the rule and have been fighting in the courts to get it thrown out. They say FERC Order 745 overcompensates demand response providers for resources that should not be on par with generation. The opposition also argues that FERC has no jurisdiction over demand response because the states have the exclusive right to regulate retail markets.
FERC and demand response advocates believe that demand response at the wholesale market level falls squarely within FERC’s jurisdiction. FERC argues that because retail customers are choosing to participate in the wholesale markets and that participation affects wholesale market rates, FERC can set rules and compensation for participation of retail resources in the wholesale markets.
The May 2014 decision by the D.C. Circuit Court of Appeals to invalidate the order threw the markets into a state of legal uncertainty.
Now, these arguments will come before the highest court in the land, setting up a showdown in the national spotlight between traditional generators and demand response providers.
The possible outcomes of the case
Depending on whom you talk to, the case could be heard as early as this summer and as late as next year. But the widely held expectation among those close to the case is that oral arguments will take place in the fall and a decision is expected early next year.
But a decision in the case may not be as simple as it sounds. The Supreme Court must decide two distinct questions — does FERC have jurisdiction to set rules for demand response at the wholesale level, and was the compensation set by FERC ‘arbitrary and capricious’ as the D.C. Circuit ruled? — and will rule separately on each.
“[T]here could be a combination of different answers between the two,” Brett Feldman, a senior research analyst for Navigant Research and a demand response expert, told Utility Dive.
If the case is upheld, FERC’s order will be vacated. FERC will then be responsible for determining what exactly it means and what the market impacts may be, according to Feldman.
But if the D.C. Circuit’s decision is reversed, the market would revert back to the status quo in the short term, Feldman said. In that case, he added, the Supreme Court could issue some form of stipulations about specific market participation.
Those outcomes are relatively cut-and-dry compared to the possibility of a split decisions — one that both reverses and upholds the separate aspects of the D.C. Circuit’s May ruling.
“The [Supreme Court] could reverse the D.C. Circuit’s finding that FERC has no jurisdiction, but uphold the D.C. Circuit’s determination that FERC’s pricing methodology for demand response was arbitrary and capricious,” Joseph Hall, a lawyer representing utilities and generators at the firm Dorsey & Whitney, told Utility Dive.
The implications of the case
After speaking to multiple sources on both sides, there appears to be the one thing everyone can agree on — a Supreme Court decision will go a long way towards restoring legal and market certainty. But what that certainty looks like will vary greatly depending on the Supreme Court’s interpretation.
If the decision is upheld
If the D.C. Circuit’s decision is upheld by the Supreme Court, the first thing on the docket is that FERC will need to decide what the decision means and provide guidance to industry.
“FERC will have to decide on the scope of the decision and whether it covers only the Energy market or the Capacity and/or Ancillary service markets as well,” Feldman said.
A decision to uphold will “require FERC to revise its demand response policy, or leave the matter completely to the states,” according to Hall. “This would require markets that have adopted demand response to evaluate their respective programs for compliance with the […] decision.”
If the D.C. Circuit’s decision is upheld, the “markets will continue on their current paths pushing to implement alternative rules to incorporate demand side management resources,” according to Ben Kellison, director of grid research at GTM Research.
“[T]he RTOs will have to decide how to adjust their markets as necessary,” Feldman said. “PJM, NYISO, and ISO-NE have already proposed ‘contingency’ or ‘stop-gap’ plans to allow DR to continue participating in the capacity markets on the demand side of the market.”
“These plans will probably lead to at least a short-term drop in DR because of the required transition and the reliance on the Load Serving Entities to represent the DR to varying degrees,” Feldman said.
“Some states will lead, some will follow, some will do nothing,” Feldman said. “In the long run, DR may find more value in the leading states than the wholesale markets provided.”
But Feldman also cautioned that some demand response players “may not survive the short-term shake-out,” either by getting “swallowed up” by other companies or simply deciding to leave the market.
An upheld decision, however, would be a clear boon to the bottom line of many generators. If the D.C. Circuit decision holds, “competitive generators are likely to maintain a greater premium on generation during peak periods and higher barriers to entry from DSM into any market,” Kellison said.
“Generators would appear to benefit in the short term [with] less competition,” Feldman said. “However, there is the possibility that the courts or FERC could extend the ruling to apply to generators too, meaning that the generators could face less-favorable regulatory structures.”
If the decision is reversed
However, if the decision is reversed, many say a return to the status quo is most likely in the short term.
”If the Court reverses EPSA in its entirety, then the status quo will presumably continue,” Joseph Fagan, a partner at Day Pitney and counsel for the New England Power Pool, told Utility Dive.
“Everything should continue status quo,” Feldman said. But while that may provide more stability in the short-term, it may actually hinder important developments at the retail level in the longer term, he added.
The wholesale markets “will likely return to many methods for compensation developed under FERC 745,” according to Ben Kellison, but “it will not be a full return to business as usual” for demand response.
For example, PJM’s reliability requirements have changed since the case began, while the D.C. Circuit also overturned an EPA rule last week that will negatively impact the ability of backup generators to provide emergency demand response, according to Kellison.
“The decision is likely to take a few years to take full effect if reversed as the vast majority of revenue and volume of demand response that participates in capacity markets are contracted years in advance,” Kellison noted.
If a reversal were to take place, demand response providers “are likely to pull back from efforts to resaturate the capacity market that have occurred in the wake of nullification of the order,” he said. “Instead, many of the resources under contract, will transition in the next few years to economic demand response markets in search of greater premiums and lower reliability requirements, as C&I customers lacking firm resources reengage with economic demand response markets.”
Competitive generators, on the other hand, would likely see their “margins shrink during peak days as more flexibility from DSM enters the market,” Kellison said.
“DR could impact coal and nuclear plant retirement decisions by keeping down wholesale prices,” Feldman said. However, he also pointed out that PJM’s Capacity Performance and ISO-NE’s Performance Incentive will likely hurt demand response and boost traditional generation.
Will the legal battles end here?
Despite the degree of certainty that a Supreme Court decision would provide, Hall and Fagan do not believe that the legal battles will end there.
Even in a situation where the EPSA ruling is upheld by the Supreme Court, “unless the FERC were to direct removal of demand response resources from the organized capacity markets, presumably there will be further litigation at FERC concerning those markets,” Fagan told Utility Dive.
This brings into consideration the role of demand response in other markets where the resource has an even greater presence. In the wake of the D.C. Circuit’s May 2014 decision to vacate FERC Order 745, FirstEnergy filed a complaint with FERC, asking the agency to remove demand response from PJM’s capacity markets. A decision on that complaint could have implications that exceed the EPSA case.
“I can’t imagine FERC taking the First Energy case until EPSA is concluded,” Feldman said. “There is no way FERC will side with First Energy unless EPSA is upheld by the Supreme Court.”
“Even then,” he continued, “it will depend on the exact interpretation by FERC of the Court’s final ruling. If EPSA gets reversed, the First Energy case is dead. In any case, the RTOs are working on contingency plans.”
The bigger picture: Why the EPSA case is not just about demand response
While demand response may soon have its proverbial 15 minutes in the national spotlight, some legal experts believe the Supreme Court may have picked up the case because it simply wants to weigh on the issue of state vs. federal jurisdiction. Even if that is the case, any decision on jurisdiction will have wide-ranging implications for the power sector, which has been caught in the balance between federal and state-level policy and regulation.
"The industry is changing rapidly and the lines between federal and state jurisdiction over utility activities is becoming increasingly blurred," Hall told Utility Dive. "The case is probably just the beginning of a series of proceedings concerning disputes over federal and state jurisdiction over the next several years."
Hall pointed to several issues that sit at the edge of state v. federal jurisdiction: whether sales of distributed generation are wholesale sales for resale, which would traditionally make them subject to FERC jurisdiction, and whether states or the federal government are responsible for grid reliability and cybersecurity.
"Both sides have put together arguments on the jurisdictional issue," Hall said. "We'll see where the court comes down."
Ultimately, everyone Utility Dive spoke with agreed that no matter the outcome of the case, demand response is not going away as a resource.
"Demand response is here to stay," Hall said. "Whatever comes out of the Supreme Court case, the market will adjust and the issue becomes — what's fair pricing?"